Is Your Apartment Like a Dot-Com Stock?

What the tech-stock boom and bust can
teach us about New York real estate—and what it can’t.

It looks an awful lot like a movie you’ve seen before, and not so long ago.

Prices are in the stratosphere. Everyone’s making money—on paper. Sellers are asking for the moon. Buyers are ponying up and then flipping for more. Investment clubs are proliferating. Amateurs are quitting their day jobs. Professionals are dreaming up new financial instruments to increase their leverage. A somber chorus of experts is issuing warnings about risks, bubbles, and insanity, but the market is ignoring them. For no apparent reason, prices have risen some 30 percent since the beginning of the year.

If you think you’ve seen this movie before, then you think you know how it ends: with catastrophic drops in prices; assets that are suddenly, irrevocably illiquid; and a long, painful morning after. At least, that’s what happened when the tech bubble burst.

But wait. Maybe New York real estate is different, with a happy ending, except for those unlucky few who walked out or never got in. Houses aren’t like stocks—they’re real assets. Even if prices drop, you can live in your house—something you can’t do with shares of Cisco Systems. Real estate is a great long-term investment, especially in New York: They aren’t making any more land.

And more important, those who’ve waited for the crash have gotten priced out. That two-bedroom you refused to consider at $750,000 three years ago? It just sold for $1.3 million. The crappy one-bedroom-plus-den you got outbid on a year later at $900,000? It’s on again for $1.2 million. Your idiot friends who bought last year “at the top” are now $500,000 richer. You, meanwhile, are still paying rent. Rent! When you own your house, you’re building equity. When you pay rent, you’re just hosing money away.

Most of New York is currently debating these questions—just about everyone except the brokers, of course, who tend to say that things are going up, up, up (and, so far, have been right). The fact is, there is much we don’t know about this real-estate bubble, if bubble it is. Does it end with a bang, with prices plummeting and wreckage on the pavement? Or a slow leak over a number of years? Or do prices simply stay where they are—the proverbial soft landing—making speculators unhappy but bothering no one else very much? Which script should we follow, and how does it end? There are lessons to be learned from the recent past, even if we aren’t condemned to repeat it.

The scariest aspect of today’s real-estate market is the conviction that houses are always a good investment. In the nineties, the mantra was “stocks are the best investment for the long haul.” This had the benefit of being true, then and now; for 200 years, stocks have outperformed every other asset class, including real estate. But the “long haul” is long. For vast stretches of time—1901 to 1920, for example, or 1966 to 1982—stocks have performed terribly. And, in New York, the same goes for real estate.

In the past ten years, New York real estate has been a superb investment. According to the appraisal firm Miller Samuel, the median price of a Manhattan co-op has tripled since 1995, vastly exceeding the performance of, say, the S&P 500, which has merely doubled. If one takes a longer view, however, the picture changes. Miller Samuel says that the median Manhattan co-op cost the same in 1999 as it did in 1981, eighteen years earlier. Over this period, meanwhile, the S&P 500 rose tenfold (before dividends!).

Nor is it true that “real-estate prices never go down.” On the contrary, from 1986 to 1995, after the stock market crashed and the government eliminated some real-estate tax shelters, the price of the median co-op dropped by nearly half, from about $360,000 to about $200,000. Those who bought new pads in the mid-eighties were underwater for more than a decade (and weren’t talking about what a great investment real estate was).

In other words, as Warren Buffett has observed, we tend to base expectations for the future on the experience of the recent past, on what we see in the “rearview mirror.” The trouble is, the recent past is often too short to provide a meaningful picture of long-term price behavior. Real estate and stocks do tend to vacillate around long-term trends, but the vacillations often take the form of ten-to-twenty-year moves, so they are easy to mistake for permanent realities. Thus, we tend to be most bullish at the end of bull markets (when we should be most bearish) and most bearish at the end of bear markets (when we should be most bullish). Over the true “long term”—30 years or more—real estate has indeed been an excellent investment, although nowhere near as good as stocks. Over shorter periods, however, both have occasionally been disasters.

So are we living in a bubble? Well, the average New York apartment has more than doubled in price since 1996, and in some areas, prices have quintupled. New York real estate certainly looks like a lot of the bubbles we’ve seen in the past. Still, many of the commonly cited “signs of the top”—bidding wars, vertiginous prices, lines outside new condo projects, everyone and their brother becoming “real-estate developers”—can be deceptive. When Netscape went public in 1995, it, too, was dismissed as a “sign of the top,” but it was only the beginning (and the Internet is anything but a hallucination).

Those who argue that real-estate prices can only go up have bogus arguments, too, of course: immigration pressure, restrictions on development, the advantages of owning versus renting, declining interest rates. These factors may explain the recent past, but they don’t offer insight into the future, and the only one that has really changed in the last decade is interest rates. A sharp rise in interest rates would almost certainly end the boom, but a basketful of Chicken Little warnings over the past few years has illustrated how hard it is to predict when this will occur.